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What do mainstream economists think about the minimum wage?

A third think it's bad, while slightly less than a quarter think it's fine. Or so it seems according to David Colander. In the update of his 1987 analysis of "The Making of an Economist" (original one with Arjo Klamer; subscription required) David asked graduate students what did they think about several economic issues (a short version here; the book here). I have some doubts about David's new overall conclusion about the state of the profession, in particular his views on how the profession has changed (see for example my debate here), but there are several interesting points raised by the replies given by the graduate students of 6 mainstream programs. One is related to their views about the minimum wage.

The table (from the book) shows the views then (1987) and now (2005), by publication dates, on whether the minimum wage increases unemployment among young unskilled workers. The evidence seems to suggest overall there is not much of a change, with 34% back then and 33% now agreeing with the conventional neoclassical proposition. But a small change suggests that more economists believe that the minimum wage does NOT lead to unemployment now, from 18% to 23%. In Chicago the percentage of graduate students holding a conventional view fell from 70% to 56%. Only Harvard seems to go in the opposite direction. MIT shows the biggest increase among those that disagree with the conventional view (from 11% to 30%).

There are several problems with the conventional mainstream (marginalist) story about the effects of minimum wages. The capital debates actually are relevant here too. There is no reason to believe that firms will hire more workers when the price of labor falls, exactly for the same reasons that hold for capital. The principle of substitution does not necessarily work, and there is no relation between the intensity of the use of a factor of production (labor) and its remuneration (real wage). Put in simple terms, there is no reason to hire workers, even if their wages are lower, if there is no demand for your products.

But the reasons for the change in views, small as they are, are not related to the logical flaws of the mainstream model. I don't even think it is solely the increasing evidence since the publication of Card and Krueger's analysis (here; discussed here too), about the absence of a negative effect of minimum wage increases on employment, that has been the driving force in these changing views. My guess is that income inequality has played a role in the willingness of mainstream students to reject the conclusions of the theory they are taught. But in order to really know why, we would need another survey.

Hi Trixie:Actually the idea of the K debates is pretty simple. THink of a situation in which the price of a certain machine used in the production of a few consumption goods falls, one would expect that substitution effects would lead to increased demand for that machine. Depending on the elasticity of the demand for that machine, however, the income of the producer may fall, and if we assume that the producer demands consumer goods that are intensive in the use of that particular machine, then the fall in the price of the machine may ultimately lead to less demand for that machine. The income effect would be perverse and could more than compensate the substitution effect. The fact that the machine is a produced good used in the production of other goods generates an interdependence that invalidates the generality of the neoclassical views on scarcity and relative price.

Thanks Matias. For me, what you say is intuitive and easy to digest, but it helps to understand what the hell the debate was even about. The problem, I think, is that I continue to struggle with the neoclassical views. I just don't get it! It's also really difficult to keep all the 'schools' straight.

I just now came across a reddit link to a presentation by Marc Lavoie. The high-level compare/contrast format is very helpful:

If there is no reason to hire workers if the company does not have additional product to sell then isn't so that the company will sell less product if the cost of inputs, in this case labor, increases?

I would answer it in another way. If you assume that a wage increase won't affect the aggregate demand, then this reduction will only affect the amount of product a company sells if it takes the profit rate to a level lower than a minimum acceptable one. Otherwise, it will only reduce the profit rate, but sales will remain in the same level that equals aggregate demand.

I don really get your question. The firm will sell more products if there is more demand. If the costs are so high that it is not profitable to sell (if there is demand) they will pass the higher costs to prices. Mind you, from an analytical point of view it is usually better to treat the sources of prices (costs) separate from the ones that determine quantities (output produced according to demand).

Matias, You say “there is no reason to hire workers, even if their wages are lower, if there is no demand for your products..”.

If you’re saying that a wage cut cuts demand, I don’t agree. If wages are cut, then profits rise all else equal. And assuming the population as a whole (employers and employees) spend the same proportion of their income as before, then all that happens is there is more demand for McMansions, and less demand for the stuff that wage earners buy. I.e. there’s no effect on demand.

I’m not sure, but didn’t Keynes claim that the effect of wage cuts on demand would be about zero?

I don't think that this is what Matias means. In my opinion, what he's saying is just that there won't be any substitution of capital for labor when wages decreases (this explains his reference to the capital debates). Firms will sell on the aggregate an amount equal (tending to, better said) to the effective demand.Regarding the relation between wage changes and demand I cannot agree with you. Assuming that people with lower income will tend to have a bigger propensity to consume than the ones with higher income, an increase in wages will tend to affect positively the demand. However, if will mean that you cannot consistently grow based on wage increases, then I'll have to agree with you because it also represents a cost factor. In other words, a totally wage-led system does not seems logically possible.

Hi Ralph:What you are adducing to is the possibility of a profit-led consumption (I have more restrictions to an investment-led one) boom. Is it possible? Sure, but unlikely. I would follow Keynes, that says in chapter 19 of the GT:

"A reduction of money-wages will somewhat reduce prices. It will, therefore, involve some redistribution of real income (a) from wage-earners to other factors entering into marginal prime cost whose remuneration has not been reduced, and (b) from entrepreneurs to rentiers to whom a certain income fixed in terms of money has been guaranteed.

What will be the effect of this redistribution on the propensity to consume for the community as a whole? The transfer from wage-earners to other factors is likely to diminish the propensity to consume. The effect of the transfer from entrepreneurs to rentiers is more open to doubt. But if rentiers represent on the whole the richer section of the community and those whose standard of life is least flexible, then the effect of this also will be unfavourable. What the net result will be on a balance of considerations, we can only guess. Probably it is more likely to be adverse than favourable."

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